Once upon a time, there was a world where people could buy pieces of companies and profit if those companies did well, or lose money if the companies performed poorly. So this huge industry sprang up to take advantage of people who wanted in on the action but didn’t have the time/interest/skills to make decisions about how to invest. This industry grew its profits by capitalizing on people’s confusion, and making this whole ‘investing’ thing out to be very complicated. That world is our world.
Let’s go the very basics – two facts that, if you learn them, will get you most of the way to a decent investing strategy. Fact 1 – returns of index funds beat most actively managed funds. Fact 2 – Vanguard is owned entirely by its clients, so your interests and Vanguard’s interests are one and the same.
When you pay someone to manage your money by investing in actively managed funds, your profit is equal to the investment returns net (excluding) fees. If you’re paying 2% for fees, that’s 2% less money that goes in your pocket. On the other hand, if you invest in funds managed by brilliant people, you’ll totes make up that loss due to their superior skillz, right? Turns out, not so much. Most actively managed funds are under-performing their indexes. Index funds are essentially a broad selection of companies, so index returns reflect average returns across the asset area. The good news is that indexes’ costs are extremely low (<.2% in some cases), and that getting average results puts you ahead of the many people who try to be clever and smart and time the market and bet on individual companies.
Next we come to Vanguard – I am a little bit in love the company and Jack Bogle (the founder). We all know that it’s … enlightening to know the motivations of all parties involved in a situation that involves your hard-earned money. Unlike other mutual fund companies (Fidelity, Schwab, etc) nobody but the clients (you & me, for instance) owns Vanguard. Neither the CEO nor the founder own Vanguard. Thus, none of the fund expenses go to an owner, and Vanguard operates at cost. This means lower expenses for you – it also means that what benefits Vanguard benefits you. And you want to keep your money with a company who’s in your court.
The reason why investing (simple as it is in theory) is so hard – is because you can’t predict what will happen in the market. In fact, it’s a guarantee that we will have many more declines – I don’t know when, but they will happen. The good news is that in the long term (30 years), stock returns have always surpassed inflation in the US, and have yielded positive returns. So, for a short term horizon (money you need within 5 years) investing might not be a great idea – what if it’s one of those 5-year periods where you lose 40% of what you invested? Even if you’re in it for the long term, most people tend to panic and take their money out after such huge losses. This is the biggest mistake of all – you often end up losing out on the subsequent growth and returns.
What do you think is the hardest or most intimidating thing about investing?